Vertical Integration
Vertical Integration in the Swiss Watch Making Industry: A Case Study of Rolex
Most firms exist to maximize profits. In order to maximize profits, firms must either increase revenue by increasing demand or reduce cost by exploiting economies of scale and reaching the minimum efficient scale. The motivation towards cost reduction has given rise to large aggregate producers, firms who mass produce to sell to other firms in the market. In this report we will refer to these aggregators as “market firms”. However, despite the increasing trend towards outsourcing due to lower costs of production, some companies still choose to vertical integrate. In trying to understand the make-buy dilemma, we will analyze the case study of Rolex with particular emphasis on transaction cost, risk and coordination efficiency.
Through a strategy of backward vertical integration which started over 10 years ago, Rolex has managed to vertical integrate virtually every aspect of its manufacturing process. Rolex now designs, produces and assembles almost all of its watch parts in-house.
Difficulty in Finding Supplier
In 2003, Rolex made the decision to replace the use of 361L graded steel which is used by all other watchmakers to 904L steel. 904L steel is a harder grade of steel which is more rust and corrosion resistant, more importantly the steel is able to hold its shine better and longer as compared to 361L. The rationale for doing it in-house is probably due to the fact that Rolex being the only watchmaker doing it, there is no other firm currently supplying it. Hence the cost of self-production and outsourcing will probably be the same due to similar levels of economies of scale.
Furthermore any potential market firm would have to invest into relationship-specific assets, which are assets which supports a specific transaction and cannot be redeployed to another without incurring additional costs (Besanko, Dranove and Shanley, 2000). In this case the assets are dedicated in nature,
Most firms exist to maximize profits. In order to maximize profits, firms must either increase revenue by increasing demand or reduce cost by exploiting economies of scale and reaching the minimum efficient scale. The motivation towards cost reduction has given rise to large aggregate producers, firms who mass produce to sell to other firms in the market. In this report we will refer to these aggregators as “market firms”. However, despite the increasing trend towards outsourcing due to lower costs of production, some companies still choose to vertical integrate. In trying to understand the make-buy dilemma, we will analyze the case study of Rolex with particular emphasis on transaction cost, risk and coordination efficiency.
Through a strategy of backward vertical integration which started over 10 years ago, Rolex has managed to vertical integrate virtually every aspect of its manufacturing process. Rolex now designs, produces and assembles almost all of its watch parts in-house.
Difficulty in Finding Supplier
In 2003, Rolex made the decision to replace the use of 361L graded steel which is used by all other watchmakers to 904L steel. 904L steel is a harder grade of steel which is more rust and corrosion resistant, more importantly the steel is able to hold its shine better and longer as compared to 361L. The rationale for doing it in-house is probably due to the fact that Rolex being the only watchmaker doing it, there is no other firm currently supplying it. Hence the cost of self-production and outsourcing will probably be the same due to similar levels of economies of scale.
Furthermore any potential market firm would have to invest into relationship-specific assets, which are assets which supports a specific transaction and cannot be redeployed to another without incurring additional costs (Besanko, Dranove and Shanley, 2000). In this case the assets are dedicated in nature,